China Inflation Pressure Mounts

The Chinese government’s efforts to control inflation are showing no signs of yielding results.

The National Development and Reform Commission (NDRC) admitted yesterday that the government was finding it difficult to achieve its full-year inflation target of below 4%. It cited high global commodity prices as a major factor driving up local production costs.

Consumer price inflation in July hit a 3-year high of 6.5% while the producer price index jumped 7.5%. Food costs soared 14.6% as the price of pork, a staple food, increased by nearly 57%.

Although some analysts expect a slight easing in inflation from August the government does not seem to share these expectations.

Late last week the People’s Bank of China reportedly took fresh measures to tighten liquidity, asking banks to include their margin deposits (collateral deposited in banks against LCs and letters of guarantee) in the reserves required to be kept at the central bank. Analysts expected this move to reduce liquidity by about Yuan 800-900bn ($125-141bn).

This could further hamper chemicals trade. As we have discussed before on the blog, chemicals traders have struggled since late last year to source credit.

The deputy director of the China Association of Small and Medium Enterprises warned in this interview that if inflation and power shortages continue, 40% of SMEs in Zhenjiang would go bankrupt next year.

This places the government in a difficult position. On the one hand liquidity controls have become a must to tackle inflation and on the other hand SMEs, the lifeline of the country, need to be supported.

Some economists think that the government may take measures to ease credit to SMEs, as has been rumoured in chemicals markets for several weeks.

But any such measures would have to be carefully targeted and well-policed, a sales and marketing executive with a global polyolefins producer told the blog in July.

It is often the case in China that lending intended for one purpose gets diverted elsewhere. For example, LCs opened to ostensibly buy polyethylene (PE) are being used to complete property deals because of restrictions on lending to the property sector, the senior source added.

Deutsche Bank’s economist believes that the government may start loosening monetary policy in the fourth quarter as growth in the US and Europe slows and global commodity prices start easing.

But not everyone is convinced and recent developments suggest that a loosening of the country’s monetary policy is unlikely to take place soon.